TRUE-FALSE STATEMENTS

1. In making decisions, management considers only financial information because accounting is presented in
financial context.

2. Decision-making involves reviewing the results of a decision once the decision has been made.

3. In incremental analysis, total fixed costs will always remain constant under alternative courses of action.

4. Incremental analysis is also known as differential analysis.

5. Incremental analysis identifies the probable effects of management decisions on future earnings.

6. Decisions made using incremental analysis focus on the amounts which differ among the alternatives.

7. The process used to identify the financial data that change under alternative courses of action is called
incremental analysis.

8. Sunk costs are considered relevant when choosing among alternatives because they are differential.

9. Incremental costs are always relevant in decision making.

10. A special one-time order is acceptable if the unit sales price is greater than the unit variable cost.

11. Max company has excess capacity. A customer proposes to buy 400 widgets at a special unit price even
though the price is less than the unit variable cost to manufacture the widget. Max should accept the
special order if demand for other products is unaffected.

12. A company should accept an order for its product at less than its regular sales price if the incremental
revenue exceeds the incremental costs.

13. If a company is operating at less than capacity, the incremental costs of a special order will likely include
variable manufacturing costs, but not fixed costs.

14. A decision whether to continue to buy a product instead of producing it internally depends on the
incremental costs and incremental revenues of making the change.

15. An opportunity cost is the potential benefit given up by using resources in an alternative course of action.

16. An incremental make-or-buy decision depends solely on which alternative is the lowest cost alternative.

17. Direct materials, direct labor, and allocated fixed and variable manufacturing overhead are all relevant in
a make-or-buy decision.

18. A disadvantage of using an outside supplier is the associated loss of control over the production process.

19. In a sell or process further decision, management should process further as long as the incremental
revenues from additional processing are greater than the incremental costs.

20. It is better to process further rather than sell now if the sales price increases.

21. The basic decision rule in a sell or process further decision is: process further if the incremental revenue
from processing exceeds the incremental processing costs.
 22. In a decision concerning replacing old equipment with new equipment, the book value of the old
equipment can be considered an opportunity cost.

23. In a decision to retain or replace old equipment, the salvage value of the old equipment is a sunk cost in
incremental analysis.

24. Equipment that is not fully depreciated should always be replaced.

25. The book value of old equipment is an opportunity cost.

26. A company should eliminate any segment in which the contribution margin is less than the fixed costs that
are unavoidable.

27. The elimination of an unprofitable product line will always increase the total profits of a company.

28. A company’s net income could decrease if an unprofitable segment is discontinued.

29. In deciding the future status of an unprofitable segment, management should recognize that net income
will increase by eliminating the unprofitable segment.

30. If an unprofitable product is eliminated, fixed expenses allocated to the eliminated segment will likely be
eliminated.

Ex. 171
Smooth Brew Company manufactures cappuccino makers. For the first eight months of 2008, the company
reported the following results while operating at 80% of plant capacity:

Sales (50,000 units) $9,000,000

Cost of goods sold 5,400,000
Gross profit 3,600,000
Operating expenses 2,400,000
Net income $1,200,000

An analysis of costs and expenses reveals that variable cost of goods sold is $95 per unit and variable operating
expenses are $35 per unit.

In September, Smooth Brew receives a special order for 3,000 machines at $135 each from a major coffee shop
franchise. Acceptance of the order would result in $2,000 of shipping costs but no increase in fixed expenses.

Instructions
(a) Prepare an incremental analysis for the special order.
(b) Should Smooth Brew accept the special order? Justify your answer.

Ex. 172
Vincent Company supplies schools with floor mattresses to use in physical education classes. Vincent has received
a special order from a large school district to buy 400 mats at $40 each. Acceptance of the special order will not
affect fixed costs but will result in $800 of shipping costs.

For the first 6 months of 2008, the company reported the following results while operating at 70% capacity:
 Sales (25,000 units) $1,250,000
Cost of goods sold 980,000
Gross profit 270,000
Operating expenses 170,000
Net income $ 100,000
Cost of goods sold was 75% variable and 25% fixed; operating expenses were 70% variable and 30% fixed.

Instructions
(a) Prepare an incremental analysis for the special order.
(b) Should Vincent Company accept the special order? Justify your answer.

Ex. 173
Paulsen Company produced and sold 20,000 units of product and is operating at 80% of plant capacity. Unit
information about its product is as follows:
Sales price $70
Variable manufacturing cost $45
Fixed manufacturing cost ($300,000 ÷ 20,000) 15 60
Profit per unit $10

The company received a proposal from a foreign company to buy 4,000 units of Paulsen Company's product for
$50 per unit. This is a one-time only order and acceptance of this proposal will not affect the company's regular
sales. The president of Paulsen Company is reluctant to accept the proposal because he is concerned that the
company will lose money on the special order. All fixed costs are allocated to individual products.

Instructions
Prepare a schedule reflecting an incremental analysis of this proposal and indicate the effect the acceptance of this
order might have on the company's income.

Ex. 174
Turner, Inc. budgeted 10,000 widgets for production during 2008. Turner has capacity to produce 12,000 units.
Fixed factory overhead is allocated using ABC. The following estimated costs were provided:
Direct materials ($6/unit) $ 60,000
Direct labor ($15/hr × 2 hrs./unit) 300,000
Variable manufacturing overhead ($3/unit) 30,000
Fixed factory overhead ($4/unit) 40,000
Total $430,000
Cost per unit $43.00

Instructions
Answer each of the following independent questions:
(a) Turner received an order for 1,000 units from a new customer in a country in which Turner has never done
business. This customer has offered $41 per widget. Should Turner accept the order?
(b) Turner received an offer from another company to manufacture the same quality widgets for $38. Should
Turner let someone else manufacture all 10,000 widgets and focus only on distribution?
Ex. 175
Carlsen Company manufactured 6,000 units of a component part that is used in its product and incurred the
following costs:
Direct materials $ 70,000
Direct labor 30,000
Variable manufacturing overhead 20,000
Fixed manufacturing overhead 40,000
$160,000
Another company has offered to sell the same component part to the company for $24 per unit. The fixed
manufacturing overhead consists mainly of depreciation on the equipment used to manufacture the part and
would not be reduced if the component part was purchased from the outside firm. If the component part is
purchased from the outside firm, Carlsen Company has the opportunity to use the factory equipment to produce
another product which is estimated to have a contribution margin of $30,000.
Instructions
Prepare an incremental analysis report for Carlsen Company which can serve as informational input into this make-
or-buy decision.

Ex. 176
Escher Skateboards Company has been manufacturing its own wheels for its skateboards. The company is currently
operating at 100% capacity, and variable manufacturing overhead is charged to production at the rate of 30% of
direct labor cost. The direct materials and direct labor cost per unit to make the bicycle seats are $1.50 and $1.80,
respectively. Normal production is 250,000 wheels per year.

A supplier offers to make the wheels at a price of $4 each. If the skateboard company accepts this offer, all variable
manufacturing costs will be eliminated, but the $42,000 of fixed manufactur-ing overhead currently being charged
to the bicycle seats will have to be absorbed by other products.
Instructions
(a) Prepare the incremental analysis for the decision to make or buy the bicycle seats.
(b) Should Escher Skateboards buy the seats from the outside supplier? Justify your answer.

Ex. 177
Jackson Chemical Corporation produces a water-based pest control chemical which it sells to pest control
companies to manufacture as a pesticide. In 2008, the company incurred $140,000 of costs to produce 14,000
gallons of the chemical. The selling price of the chemical is $21.00 per gallon. The costs per unit to manufacture a
gallon of the chemical are presented below:
Direct materials $ 3.50
Direct labor 3.00
Variable manufacturing overhead 2.00
Fixed manufacturing overhead 1.50
Total manufacturing costs $10.00

The company is considering manufacturing the pesticide itself. If the company processes the chemical further and
manufactures the pesticide itself, the following additional costs per gallon will be incurred: Direct materials $1.00,
Direct labor $.50, Variable manufacturing overhead $1.00. No increase in fixed manufacturing overhead is
expected. The company can sell the pesticide at $25.00 per gallon.

Instructions
Determine the incremental per gallon increase in net income and the total increase in net income if the company
manufactures the pesticide.

Ex. 179
Cheatem and Howe, Attorneys, relies heavily on a color laser printer to process its paperwork. Recently the printer
has not functioned well and print jobs are not being processed. Management is considering updating the printer
with a faster model.
Current Printer New Model
Original purchase cost $20,000 $16,000
Accumulated depreciation 11,000 —
Estimated operating costs (annual) 2,000 1,000
Useful life 4 years 4 years

If sold now, the current printer would have a salvage value of $3,000. If operated for the remainder of its useful
life, the current printer would have zero salvage value. The new printer is expected to have zero salvage value after
four years.

Instructions
Prepare an analysis to show whether the company should retain or replace the printer.

Ex. 180
Herman Corporation operates two divisions, the A Division and the B Division. Both divisions manufacture and sell
logs to paper manufacturers. The company is considering disposing of the B Division since it has been consistently
unprofitable for a number of years. The income statements for the two divisions for the year ended December 31,
2008 are presented below:
A Division B Division Total
Sales $400,000 $300,000 $700,000
Cost of goods sold 150,000 200,000 350,000
Gross profit 250,000 100,000 350,000
Selling & administrative expenses 200,000 120,000 320,000
Net income $ 50,000 $ (20,000) $ 30,000

In the B Division, 80% of the cost of goods sold are variable costs and 30% of selling and administrative expenses
are variable costs. The management of the company feels it can save $30,000 of fixed cost of goods sold and
$30,000 of fixed selling expenses if it discontinues operation of the B Division.
Instructions
(a) Determine whether the company should discontinue operating the B Division.
(b) If the company had discontinued the division for 2008, determine what net income would have been.
Ex. 181
A recent accounting graduate from Duke University evaluated the operating performance of Fane Company's three
divisions. The following presentation was made to Fane's Board of Directors. During the presentation, the
accountant made the recommendation to eliminate the Southern Division, stating that total net income would
increase by $20,000 as shown in the analysis below.
Other Two Divisions Southern Division Total
Sales $1,000,000 $300,000 $1,300,000
Cost of Goods Sold 650,000 200,000 850,000
Gross Profit 350,000 100,000 450,000
Operating Expenses 100,000 120,000 220,000
Net Income $ 250,000 $ (20,000) $ 230,000

Cost of goods sold is 75% variable and operating expenses are 70% variable. If the division is eliminated, 40% of the
fixed costs will be eliminated.

Instructions
Do you concur with the new accountant's recommendation? Present a schedule to support your answer.

Ex. 182
Anheiser has three divisions: Bud, Wise, and Er. The results of May, 2008 are presented below:
Bud Wise Er Total
Units sold 3,000 5,000 2,000 10,000

Revenue $70,000 $50,000 $40,000 $160,000

Less variable costs 32,000 26,000 16,000 74,000
Less direct fixed costs 14,000 19,000 12,000 45,000
Less allocated fixed costs 6,000 10,000 4,000 20,000
Net income $18,000 $ (5,000) $ 8,000 $ 21,000

All of the allocated costs will continue even if a division is discontinued. Anheiser allocates indirect fixed costs
based on the number of units to be sold. Since the Wise division has a net loss, Anheiser feels that it should be
discontinued. Anheiser thinks if the division is closed, sales at the Bud division will increase by 15%, and sales at
the Er division will stay the same.

Instructions
(a) Prepare an analysis showing the effect of discontinuing the Wise division.
(b) Should Anheiser close the Wise division? Briefly indicate why or why not.